Carpenter Technology Corp (CRS) 2006 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter Carpenter Technologies earnings conference call. My name is Jennifer, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions).

I will now hand the presentation over to Mr. Jaime Vasquez, Vice President and Treasurer.

Good morning. Welcome to our conference call for the period ended December 31, 2005, the second quarter of Carpenter's fiscal year. This call is also being broadcast over the Internet. With me today are Bob Torcolini, Chairman, President, and Chief Executive Officer; Terry Geremski, Senior Vice President - Finance and Chief Financial Officer; Dennis Oates, Senior Vice President of our Specialty Alloys operations; and Rick Simons, our Vice President and Corporate Controller. Some of Carpenter's statements will be forward-looking statements, which are based on current expectations. Risk factors that could cause actual results to differ materially from these forward-looking statements can be found in Carpenter's recent SEC filings, including the Company's June 30th, 2005 10-K subsequent, Form 10-Q and exhibits attached to those filings. During this conference call, we will be using abbreviations SAO to represent Specialty Alloys Operations and EPG to represent our Engineered Products Group.

I will now turn the call over to Bob, who will start with a brief overview.

Thank you, Jaime, and good morning. Earlier today, we distributed a news release on the results of our second quarter and first half of fiscal year 2006. We are pleased to report record second-quarter earnings.

Our performance was driven by solid demand for our higher-value materials across key markets worldwide. In particular, we experienced continued, strong demand for our special alloys, titanium, and ceramic materials as a result of increasing commercial aircraft deliveries. The strong worldwide demand for these materials helps us to achieve our 10th consecutive quarter of double-digit foreign sales growth, which accounted for 31% of consolidated sales in the quarter.

The sales growth, coupled with our focus on eliminating marginally profitable business and cost reduction through lean and variation reduction has significantly enhanced our operating leverage. The strength of our business operating model allowed us to achieve the second highest level of quarterly net income in Carpenter's history. This was accomplished during what is normally one of the slowest quarters of the year.

Now let me provide you with some detail on Carpenter's consolidated second-quarter sales, first by product type and then by end-use market. The year-over-year changes in sales that I will reference include surcharges. Excluding surcharge revenues and a divested business, sales increased 16% from the second quarter a year ago.

Sales of our special alloys increased 22% from a year ago to $145 million, a record level for any quarter. The increase was driven by strong demand from the aerospace market for our special alloys used in the manufacture of jet engine components and structural components such as landing gear. The strength of special alloy sales also reflected continued growth within the medical market, as well as higher base prices and surcharges. We expect that our special alloy sales will continue to enjoy solid growth as a result of the significant rise in commercial aircraft deliveries expected over the next few years and the favorable long-term trend in the medical market.

Our stainless steel sales were $120 million, or 9% below the second quarter a year ago. Sales in the quarter reflect our strategy not to pursue lower-margin business and inventory adjustments within certain supply channels and reduced sales to the industrial consumer and automotive markets. Based on current activity, we believe that several of these markets have now stabilized.

Sales of our titanium alloys increased 60% to $41 million, also a record for any quarter. Titanium is enjoying particularly robust demand, not only because of the increase in the number of aircraft being built but also by the specific models that are being ordered. The demand for new wide-body aircraft typically requires a greater use of lighter-weight materials such as titanium. This should continue to drive demand for our titanium materials over the next several years, with deliveries for the Airbus A380 and Boeing 787 beginning in 2007. Our titanium materials also benefited from growth within the domestic and foreign medical markets.

Sales of ceramic and other materials increased 12% from the second quarter a year ago to $25 million. The increase is primarily attributable to strong demand from the aerospace market for ceramic cores used in the casting of turbine blades for jet engines.

By end-use markets, sales to the aerospace market increased 44 percent from the same quarter a year ago to $129 million. This was the eighth consecutive quarter of increased sales to the aerospace market, and was a record for any quarter. The upcoming number of commercial aircraft deliveries, as well as the increasing proportion of larger aircraft in the mix should sustain demand for several of our businesses.

Sales to the medical market were $34 million, up 63% from a year ago, a record for any quarter. The record sales level reflected growth with key customers, strong demand from Europe, and pricing actions. We continue to see steady growth of our special alloys and titanium materials in both the domestic and foreign medical markets.

Sales to the power generation market were $13 million or 27% lower than a year ago. However, after adjusting sales for a business divested in last year's fourth quarter, power generation market sales rose 20%. Pricing actions, surcharges, and increased demand from maintenance activity on industrial gas turbines were the primary contributors to the increase.

Sales to the automotive and truck market were $41 million, up 1% from the second quarter a year ago. Solid demand from the heavy-duty truck market offset reduced automotive production levels and corresponding inventory adjustments within the supply chain.

Industrial sector sales, which include materials used in equipment and other capital goods applications, decreased 12% from the second quarter a year ago to $82 million. The drop in industrial sector sales was primarily due to the intentional reduction in the sale of marginally profitable business, as well as inventory adjustments within certain supply channels.

Sales to the consumer market of $48 million decreased 7% from a year ago. Consumer market results also reflect our strategy not to pursue marginally profitable business, and reduced demand from the housing and electronics markets.

Now I will provide an overview of our business units. Starting with SAO, second quarter sales of $273 million were 11% higher than a year ago. The increase was primarily due to the sale of higher-value materials to the aerospace markets, base pricing actions, and surcharges.

Volumes this quarter declined 18% from a year ago. The decline reflects our strategy not to pursue marginally profitable business and inventory adjustments within certain supply channels. A large portion of these products are more generic, and are sold into the independent metals distribution market, which is typically more price sensitive. SAO also experienced lower demand from the consumer, industrial, and automotive markets.

Sales of bar products decreased 3% from the second quarter a year ago. A more favorable product mix, pricing actions, and surcharges mostly offset a 26% decline in bar shipments. As I just mentioned, the decline in shipments is associated with our decision not to produce the more generic products. Bar shipments also declined as a result of inventory adjustments within certain supply channels.

Our forged bar and billet product sales increased 53% from a year ago. The primary drivers were an 8% increase in shipments to the aerospace and power generation markets, increased foreign sales, higher base selling prices, and surcharges.

Sales of coil products increased 5%, although shipments were down 18%. A better product mix and higher selling prices more than compensated for lower shipments that resulted primarily from the intentional reduction of marginally profitable business.

At Dynamet, which primarily sells titanium products, second-quarter sales increased 60% from a year ago to $38 million, a record level for any quarter. The increase reflected the strength of the aerospace market, continued growth in the domestic and foreign medical markets, and higher base selling prices. Dynamet's business is expected to benefit from the robust demand for new aircraft and the larger mix of wide-body aircraft that will be delivered over the next few years. Also, Dynamet's growth in the domestic and foreign medical markets should further aid its performance.

Sales for the Engineered Products Group were $25.3 million in the second quarter compared to $32.5 million in the quarter a year ago. However, last year's second-quarter sales included $9.5 million from Carpenter's special products, which was divested in the fourth quarter of 2005. Adjusting for those sales, Engineered Product Group sales were up 10% from a year ago.

Certech, which produces ceramic cores used in the casting of turbine blades and diesel engine fuel injectors, experienced solid demand from the power generation, truck, and aerospace markets.

Now I would like to turn the call over to Terry.

Thank you, Bob. As Bob highlighted, second-quarter sales growth benefited from increased sales of higher-value products, especially to the aerospace and medical markets; higher base selling prices; and surcharges.

Carpenter's sales for the quarter were $346 million, up 11% from $312 million reported a year ago. Adjusted for surcharge revenue and the divested business, sales this quarter increased by 16% compared to a year ago.

Gross profit in the second quarter increased to $94 million, or 27.1% of sales, from $75 million, or 23.9% of sales a year ago. The 320 basis point increase in the gross profit margin is attributable to higher base selling prices, a richer product mix and better operating efficiencies achieved through lean initiatives and variation reduction.

In the second quarter of fiscal '06, selling and administrative expenses of $30 million were 8.6% of sales compared to $30 million, or 9.5% of sales, in the same quarter a year ago. We continue to diligently manage costs, and expect that selling and administrative expenses of fiscal '06 will be near the same level as a year ago.

As a result of the increase in the gross profit margin and essentially flat selling and administrative expenses, operating income increased 42% to $64 million from $45 million last year. Operating income as a percentage of sales expanded by 410 basis points this quarter to 18.5% of sales from 14.4% last year.

Interest expense for the quarter was $5.9 million, unchanged from a year ago. Other income for the quarter was $8.7 million compared to $4.8 million in the second quarter a year ago. The increase primarily reflected higher interest income from increased balances of invested cash, increased receipts from the Continued Dumping and Subsidy Offset Act, and foreign exchange gains.

As a result of the strong operating performance, Carpenter generated record second quarter net income which totaled $42.9 million, or $1.65 per diluted share. This compares to net income of $32.5 million, or $1.28 per diluted share in the quarter a year ago.

Turning to the balance sheet, accounts receivable were $4 million higher than a year ago, due primarily to the increased level of sales. However, days sales outstanding were reduced to 47 days from 50 days at the end of the second quarter a year ago.

Inventories of $265 million were $50 million higher than a year ago. The strength of orders for higher value materials, many of which have longer throughput times, were largely responsible for the inventory increase. In many cases, actual physical stocks of inventory were reduced, although inventory values increased.

For the quarter, free cash flow was $41 million versus $15 million in the quarter a year ago. Based on the expectations for continued earnings growth and working capital improvement, we now estimate that free cash flow will be in excess of $150 million for fiscal 2006.

I'll now turn the call back to Bob for concluding remarks.

Thank you, Terry. Our ability to achieve the second-best quarter in Carpenter's history highlights the significant leverage within our business operating model. Our continued focus on lean initiatives and variation reduction will further enhance our business model, and should allow us to sustain returns above our cost to capital through all phases of the business cycle.

As we look to the balance of fiscal 2006, we see continuing strength in the demand for our aerospace materials and solid growth in other key end-use markets. Consequently, based on current market conditions, Carpenter is well positioned to achieve another record year. I would like to thank all of the people at Carpenter for their collective efforts towards elevating the performance of the Company.

Jennifer, we will now open the call to analysts' and investors' questions.

(Operator Instructions). Michael Gambardella, JPMorgan.

A couple of questions. One, for the third fiscal quarter, the quarter that we are in right now, do you have any -- or I should say, what percent of the sales mix for the whole Company has seen a price renegotiated, say, at calendar year end?

I think in past questions that we've had, and we've been asked how much of our business is under contract, and we've said it's really between 30 and 35%. And I don't think that really has changed much. And those contracts typically have -- although they are not exclusive, but I think many of them are renewed end of year, meaning (multiple speakers) January 1, and also usually middle of the year, like June 30th.

So there's a constant rollover of those and we have had several of those contracts renegotiated as a result, and are now in effect as of January 1. And many of those contracts are typically one year, sometimes 2. They're not nearly as long term as they have been in the past.

So that's an ongoing thing. And as I said, I think it's primarily a year-end and year-end phenomenon, and those have been renegotiated. And those renegotiations have occurred, indicative of the environment that we are in right now. And as we mentioned previously, some of those contracts renew at sometimes double-digit increases.

Okay, great. So it's about almost a third of your business, you think, for year end?

About a third of the business overall, and then the split is probably half and half between year-end and midyear.

Okay. And then second question, as we speak right now, the Company is probably in a negative net cash position -- more cash than debt. What are you going to do? Can you go through the priorities, what are you going to do with the excess cash that you're building up?

This is another question we talked a lot about. Basically, one thing you'll note is that through this half-year, we spent about 10 million in capital. And that's a little bit more than what we spent in the prior years. So this year, you're going to see a little bit more capital spending, both strategic capital spending and also some maintenance capital spending, although we already do pretty good spending on maintenance that is nonexpensed.

So that's ongoing thing. You'll see a little bit of an uptick there. The last two years we've actually funded [avi bottoli], and we'll certainly entertain that if that's appropriate. Remember, our capital spending in the past has been pretty extensive, particularly in the years from 1999 to 2001. However, we'll look again at those strategic expenditures within the businesses. So I would anticipate we'll see a little bit of an uptick in that.

But primarily, obviously, we, together with the Board, consider things like dividends, which you've seen that we have increased our dividends. And the other thing obviously is we'd like to profitably grow Carpenter, and that gets into the realm of strategic acquisitions.

Any consideration on share buybacks?

Share buybacks are in the mix in terms of what is the expected return on that. There's nothing imminent in terms of whether we were going to make an announcement, but it is one of those continually evaluated alternatives. And we look at the considerations of a return on a buyback versus the timing of a longer-term strategic investment.

Matt McGeary, Sentinal Asset Management.

Just a follow-up, since you're talking about it, on the M&A front, potential M&A front -- just sort of curious what you see, sort of what the environment is like. I know it's probably been a pretty tough time to try to find quality assets at a reasonable price, but just sort of curious what your perspective is now.

I think in the past we've talked about strategic acquisitions particularly on the materials side. We do have some very, very excellent metals assets in the corporation today between places like specialty alloys and Dynamet and our powder materials businesses. So we're fairly satisfied with that, although we continue to look at opportunities there.

But we're also interested in some other more advanced materials. As you know, we have two ceramics companies, and we continue to look in that space, and also just other advanced materials. That's where our interest lies.

You indicated, and I would say it's pretty common knowledge, that valuations today are very, very steep. But that being said, we continue to look. And I would also say that it's just an important opportunity for us to grow and diversify Carpenter and to build a stronger Carpenter for the future.

And when you guys talk about purposely walking away from lower-margin business, do you do that kind of on a one-off basis, or are there product lines that you're just systematically exiting? And if it's the latter, how much left do you have in that effort?

In terms of the -- what we have really been talking about for several quarters now is really a strategy to really focus on higher value, higher technology products. We have, and have had the capability, and still have the capability, to make what we refer to as more generic products. Those generic products, however, are very much subject to high competition, not only from a few domestic competitors, but also internationally. So if we're talking about things like -- we mentioned the generic stainless bar products that are being sold to the independent distribution market, traditionally, we may have sold a little bit of product into that marketplace. We've been essentially weaning ourselves out of that.

If you look at the statistics through November, stainless bar imports here in the United States are up 58%. So as pricing really firmed up in the marketplace, imports really flooded into the market, and independent distributors did place at a lot of business in that direction. So that was very consistent with our desire not to chase after marginally profitable business in that sector.

The other area has been in the area of what is called redraw rod -- in other words, there is wire rod that is sold into a market where people take that wire rod and draw it down further into other materials. We've traditionally played in that on an opportunistic basis. And over the last several quarters, what we have looked at is the returns on those types of products. And we've decided that it's just not attractive enough for us, so we've been turning our attention and our resources and our energies to toward other kinds of products.

So that's why you're hearing us talk about a reduction in volume, because when we measure volumes, those volumes -- those products typically are high volume, low price, and low margin. So that's why you hear us repeatedly talking about decreases in volume, particularly in the stainless side -- stainless bar and wire.

And lastly, a quick one, on your debt situation -- I haven't looked at your debt. Does it make any sense economically to pay down debt or not?

Currently, it doesn't. What we're finding is obviously -- it's being held in some portfolios where they find the yield appropriate. And basically, the interest that we understand the market has is -- their appetite is looking for complete make-wholes. So all we would be doing is prepaying essentially with full interest. So at the moment, it is not attractive to bring it in. But by the way, that is one of the reasons we would certainly keep some available cash to opportunistically bring in some of that debt. And we think that if rates rise a bit that some of it might free up.

Thanks, guys. Good work.

Mark Parr, Keybanc Capital Markets.

Congratulations on another great quarter. I wondered if you could address the issue of capacity utilization. And if there's any way you could talk about the different pieces, that would also be helpful -- trying to get a sense of how this balancing act between shifting out of lower-value products into higher-value plus the underlying growth -- I mean, what sort of an effect is this overall having on your ability to grow revenues via the existing asset-base?

Let's talk first about the specialty alloys business. And that is really the subject of the last comment that I made. That's where a lot of the reduction in marginally profitable business essentially decreases the capacity utilization, particularly in the finishing areas. So in the areas where we can make wire, as an example, and that wire could either go to stainless for appliances, or it could go to fasteners for aircraft, obviously by -- we've got plenty of wire finishing capacity, plenty of bar finishing capacity because of some of the shifts in mix that we've experienced and we've actually engineered.

Not all capacity is fungible, though. So we look at -- as an example, some of the primary melt capacity to make some of those products is different than the primary melt capacity to make some of the more exotic products, whether they be for medical, aerospace, oil and gas, and so on. So we have a lot of finishing capacity. And what we have is we've got melt capacity that we're utilizing and carefully allocating toward different sectors of that business, and we're actually incrementally increasing that. Some we're incrementally increasing through some of our lean and variation activities, because we're actually getting more out of the same asset.

In some cases, we're making some -- what we would call incremental strategic investments. We've invested a few million dollars to actually modernize a couple electro-slag remelting furnaces which we've now brought online. And typically, we operated with -- and we had idled one of our vacuum induction furnaces because it was the oldest -- in fact, least efficient, but actually we are operating that currently.

So we are working up -- moving up our capacity utilization, particularly as it addresses some of the higher value product opportunities that we see in the marketplace.

Is there any kind of an overall number that you'd want to put on your utilization rate in the recent quarter?

It's such a confusing rate in terms of -- we've got so much more melt capacity for certain of the generic stainless products that we're utilizing. I mean, we're not utilizing a large degree of that. We are on the other hand utilizing a fairly substantial amount of our capacity on the higher end, or the premium melted products. The other thing I'd say is that on the titanium and ceramic businesses, in both cases, we've got plenty of upside capacity there.

Okay, terrific. Thanks again, and congratulations.

Leo Larkin, Standard & Poor's.

Could you just go over the guidance for the SG&A? I was a little bit confused by that. I think you said it would approach what you did in fiscal '05, but you're way ahead so far in fiscal '06.

I believe we're kind of close to it, but we really expect for the full year that SG&A will be approximately at the same level of last year. For fiscal '05 we had -- excuse me, let me back up. Let me clarify the comment about being way ahead.

For the six months ended December 31, we were at 58.0. The prior year, we were at 57.3. So we are 700,000 ahead. For the balance of the year, I think it's about 118 or 120. Whatever the last year's number was, we are still anticipating we will be very close to that.

Okay, because I was looking at the margin. Your margin was much better for the first six months of this year. The numbers are nearly the same, but the margin is much better.

Yes.

The other question I had -- could you just refresh us with the CapEx guidance for this year?

I mentioned earlier that there's a little more spending this year. Last couple of years, we were in the 9 million for the year. Thus far, we have spent 10 million in six months, and I would anticipate we'll be somewhere in the 20 to 25 range for the year.

Bentley Offutt, Offutt Securities.

Congratulations. A question here. You'd mentioned during your preliminary discourse several of the markets appear to have stabilized. I'm assuming that one of those are power generation. But can you give us a little bit more color on what you would look for over the next year or so?

I think probably the one market that has been unstable I would say would be on the automotive side. I think starting in the middle of last calendar year with the announcements particularly from the domestic automakers and the continued announcements, including the most recent ones from Ford, I think there's a lot of uncertainty in that supply chain. And so I think people are being conservative regarding the inventory positions that they have.

And so what we've experienced is just some slowing on the automotive side of the business, not necessarily on what we would call the high-end products. A lot of the high-end products -- you noted that in the call, we've talked about the heavy-duty truck market actually continuing to be very robust, particularly in the face of some of the emission requirements, this more stringent requirements that are going to hit in 2007 -- January.

So that part of the business is very strong. And the high-performance part of the business appears to be very strong. It's really more of the generic automobiles, and particularly the domestic automobiles that are experiencing some uncertainty and softness. So that would, I would say, be the most notable.

When we also talk about our industrial markets being a little soft, one of the things that -- the way we categorize some of our sales, when we sell a lot of those products -- the ones I mentioned earlier, the more generic products that go into either the independent distributor market or even the redraw market, a lot of those get categorized into industrial. So it's not necessarily an indication of weakness in the sector as much as it is our sales to the sector reflecting our strategy to reduce our participation in those products.

Okay. And the second question I have is the number of employees. Do you have an idea of the number of employees at Carpenter at the end of the most recent quarter, and is that (multiple speakers) pretty much the same?

(multiple speakers) 3,996.

-- 996?

Just shy of 4,000.

Oh, oh -- just shy of 4,000.

Right.

So that should remain pretty stable, even though your sales have gone up significantly -- I was just interested in the sales per employee calculations relative to what it was a couple of years ago -- or operating profits per employee; it must be a rather dramatic improvement.

Well, you recall we've gone through a lot of restructuring. And as I mentioned to many people -- that in 2000, we had almost 6,000 employees at Carpenter. Today, we have about 4,000.

As there are no further questions in the queue at this time, I'll hand the presentation back to management for any closing remarks.

Okay. Thank you, Jennifer. Again, we'd like to thank everyone for your interest in Carpenter, and we will look forward to talking to you at our next quarterly conference call. Thank you very much.

Ladies and gentlemen, we thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.